Voices Growing Louder on Muni Tax Exemption

It’s hard to imagine that a tool used to finance most of the nation’s infrastructure might be on the chopping block.

Indeed, we doubt it will ultimately happen.

However, there’s enough concern from so many people that it would be unwise to ignore threats to the tax exemption on municipal bond interest and decline to act.

Municipal bond tax exemption ‘needs friends right now’

“The municipal market has enemies,” Joe Mysak, who’s covered the muni bond market for Bloomberg since 1981, said in a recent column. “It needs friends, right now, to make the case for the tax exemption.

“That means taxpayers in general and government finance officers in particular have to go to Washington and speak to their congressional delegations about the wonders and virtues of the municipal market as it is currently constituted – that is, with the interest paid on state and local obligations (mostly) exempt from taxes.”

Efforts to curtail or eliminate the 100-year-old exemption stretch back years, but the calls seem to have grown louder recently.

The blueprint for a tax overhaul issued last year by House Republicans, for example, doesn’t mention muni bonds specifically, but language referring to “special interest subsidies” and “special-interest giveaways that are masked as tax breaks instead of direct grants” is widely seen as a not-so-veiled swipe at munis.

A familiar contention by critics, noted Mysak, is that the exemption is “no more than an inefficient subsidy.” That point was made by the Tax Foundation, which, as we noted (“Too Many Potholes Filled? Blame the Muni Exemption”), argued that munis could induce cities to “over-invest” in infrastructure.

Apparently, poorly maintained roads, shoddy water systems, inadequate mass transit and overcrowded schools aren’t a problem. The more pressing concern, according to the Tax Foundation, is over-investing in our infrastructure.

A strange notion indeed.

Muni tax exemption ‘effective, efficient’

Fortunately, many lawmakers and government leaders take a different stance.

In the past few years, a slew of local, state and national lawmakers and leaders have pushed to maintain the exemption. In a letter two weeks ago, a bipartisan group of 156 members of Congress sent a letter to the House Ways and Means Committee.

The letter noted roughly two-thirds of core infrastructure investments in the United States are financed with munis, while more than $400 billion in munis were issued in 2015 alone.

“A combination of local control and local responsibility makes municipal bonds an incredibly effective and efficient tool,” the letter said.

The letter urged the committee to “recognize the vital role of tax-exempt municipal bonds” and warned, if it were eliminated, of an increase in financing costs for state and local governments.

Further, the letter said, millions of Americans depend on munis “for their economic security, and invest in them because of their low-risk nature.”

Stepping up for the muni tax exemption

Some say any move on the exemption would be part of a broad change in the tax code and wouldn’t occur before next year at the earliest (“How Recent Events Color Muni Bond Investing Strategy”). Other reports indicate the likelihood of changing or eliminating the exemption might be tied to the fate of the Border Adjustment Tax and its revenue implications.

We’re not prognosticators, so we don’t know if or when lawmakers might act on the exemption. And even if such a move were to occur, we think it’s highly unlikely Congress would tinker with municipal bonds owned by investors prior to any changes.

What is abundantly clear, though, is that supporters of the exemption must stand up now and ensure that lawmakers understand the implications of any changes. We urge you to join us in contacting your representatives in the House and Senate and lend your voice to the effort. You may also wish to contact the leaders of the House Ways and Means committee.

This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.